Stable Debt Token

A Stable Debt Token's defining feature is its fixed interest rate, which is locked in at the time of borrowing. Unlike variable-rate debt, the interest owed does not fluctuate with market conditions. This provides predictable repayment costs, making it a hedge against rising rates.

• Predictability: Borrowers know their exact cost of capital for the loan's duration.
• Mechanism: The rate is typically derived from a pool's utilization rate at the moment of borrowing and remains static.

The principal balance of the debt does not automatically decrease over time. Interest accrues on the full initial borrowed amount until the debt is fully repaid. This is a key differentiator from amortizing loans common in traditional finance.

• Accrual Model: Interest compounds, increasing the total repayment amount.
• Repayment: To settle the debt, the borrower must repay the original principal plus all accrued interest in a single transaction.

SDTs are ERC-20 standard tokens, making them freely transferable between wallets and composable with other DeFi applications. This enables secondary market activity and complex financial strategies.

• Secondary Markets: Debt positions can be sold, potentially at a premium or discount.
• DeFi Lego: Can be used as collateral in other protocols, integrated into yield strategies, or wrapped in vaults, subject to the underlying protocol's rules.

SDTs are minted exclusively by the lending protocol when a user chooses a stable interest rate option for their loan. They are not standalone assets but are derivative tokens representing a liability within a specific system.

• Minting: Occurs upon borrowing (e.g., in Aave, when selecting 'Stable Rate' mode).
• Burning: The token is burned when the debt is repaid in full to the protocol, extinguishing the liability.

Holding a Stable Debt Token represents an active loan subject to liquidation risk. If the value of the supplied collateral falls below the protocol's required health factor threshold, the position can be liquidated to repay the debt.

• Health Factor: A critical metric borrowers must monitor, calculated as (Collateral Value) / (Borrowed Value).
• Trigger: Market volatility or collateral depreciation can trigger liquidation, resulting in penalties.

The debt balance increases over time as interest accrues. This is often reflected through a rebasing mechanism, where the token's balance in the holder's wallet automatically increases, representing the growing debt obligation.

• On-Chain Accrual: Interest accrues every block, making the debt balance a function of time.
• Debt Visibility: The increasing balance provides a clear, real-time view of the total repayment amount owed.

Protocols differ in how they model stable debt:

• Tokenization: Separate ERC-20 token (Aave) vs. internal accounting scalar (Compound, Maker).
• Rate Recalculation: Fixed until user action (Aave) vs. fixed until maturity (Notional, Morpho Blue).
• Transferability: Debt as a tradable asset (Notional's fCash) vs. a non-transferable liability (standard vault debt).
• Collateral Linkage: Debt is directly tied to a specific collateral vault (Maker) vs. pooled and abstracted (Aave, Compound).

SDTs allow borrowers to lock in a fixed interest rate, insulating them from future volatility in the protocol's variable rates. This is a core risk management tool for institutions and long-term holders who require predictable liabilities.

• Mechanism: When borrowing, a user receives an SDT representing a fixed-rate loan, while the protocol manages the underlying variable-rate exposure.
• Example: A DAO treasury borrowing stablecoins to fund operations can use SDTs to ensure its debt servicing costs remain constant over the loan term.

The predictable cash flows of SDTs make them ideal building blocks for DeFi structured products and derivatives. Financial engineers can bundle, tranche, or securitize these tokens to create new yield-bearing assets.

• Principal-Protected Notes: An issuer can use yield from SDTs to fund a derivative that guarantees principal return.
• Yield Tranches: SDT cash flows can be split into senior (lower yield, lower risk) and junior (higher yield, higher risk) tranches to cater to different risk appetites.

SDTs can be used as collateral within the same or other DeFi protocols, enabling complex, capital-efficient strategies. Since they represent a debt obligation with a known repayment schedule, they can be valued and leveraged.

• Strategy: A user borrows against volatile crypto assets, receives SDTs, and then uses those SDTs as collateral to borrow additional assets, creating a leveraged but interest-rate-hedged position.
• Benefit: This allows for yield amplification while mitigating one dimension of risk (interest rate volatility).

SDTs are tradable ERC-20 tokens, creating a secondary market for fixed-rate debt. This enables interest rate speculation and provides liquidity for borrowers seeking to exit positions.

• Trading View: Traders can buy SDTs if they believe market rates will fall (making the fixed-rate token more valuable) or sell them if they believe rates will rise.
• Early Exit: A borrower can sell their SDT on the open market to transfer the debt obligation to another party, effectively closing their loan before maturity.

The primary risk is the fluctuation in the value of the underlying collateral assets. If the collateral's value falls below a predefined loan-to-value (LTV) ratio, the position can be liquidated to repay the debt, potentially at a loss to the borrower. This risk is amplified during market-wide volatility.

• Example: A user deposits ETH as collateral for a stable debt token. A sharp drop in ETH's price could trigger an automatic liquidation, selling the ETH to cover the debt.

Stable debt tokens are governed by smart contracts on a lending or money market protocol. Vulnerabilities in this code, such as logic errors or exploits, can lead to the loss of user funds. This includes risks from oracle failures, which provide faulty price data, or governance attacks that manipulate protocol parameters.

• Mitigation: Users should assess the protocol's audit history, time in production, and decentralization of its oracle network.

While the principal is stable, the interest-bearing yield is variable and subject to change based on protocol supply and demand dynamics. In extreme scenarios, a de-peg event of the underlying stablecoin (e.g., USDC, DAI) could directly impact the stable debt token's value. A bank run on the lending protocol could also freeze withdrawals or alter terms.

• Consideration: The "stable" refers to the debt principal, not the yield, which can fluctuate significantly.

Many stable debt tokens rely on centralized stablecoins (e.g., USDC, USDT) as the underlying asset. These are subject to regulatory action, freezing of addresses, or changes in redemption policies, which could cascade to the debt token. Furthermore, the governing protocol may have admin keys or centralized upgrade mechanisms that pose a single point of failure.

• Key Question: Who can freeze the underlying assets or change the rules of the protocol?

Exiting a stable debt position requires repaying the debt plus accrued interest to unlock the collateral. If the protocol's liquidity is insufficient—due to high utilization or a market crisis—users may face delays or inability to withdraw their collateral. This is distinct from but related to the risk of liquidation cascades during market stress.

• Metric to Watch: The protocol's total value locked (TVL) and reserve factors indicate available liquidity for redemptions.

Stable debt tokens are often used as money legos within DeFi (e.g., as collateral in another protocol). A failure or exploit in a downstream protocol that accepts the debt token can lead to losses. This systemic risk means the security of a position depends not only on the issuing protocol but on the entire stack of integrated smart contracts.

• Example: Using a stable debt token as collateral in a yield farming strategy multiplies the points of potential failure.

A debt token where the interest rate fluctuates based on real-time supply and demand within the lending pool's liquidity. This contrasts with a Stable Debt Token's fixed rate for the loan's duration. Borrowers bear the risk (or benefit) of rate volatility. For example, in Aave, a user can choose between a Variable Rate or a Stable Rate when borrowing an asset.

A foundational DeFi mechanism where a user locks collateral (e.g., ETH) to mint a stablecoin or borrow other assets. The debt is represented not by a transferable token, but by an internal accounting position within a smart contract (like in MakerDAO). This differs from Stable Debt Tokens, which are ERC-20 tokens representing the debt itself, making them tradable or transferable in secondary markets.

A token that accrues value over time, representing a share in a yield-generating pool. Examples include aTokens (Aave) or cTokens (Compound). While a Stable Debt Token represents a liability with a fixed cost, an ibToken represents an asset that earns a variable yield. They are often the complementary asset supplied by lenders in the same protocols that issue debt tokens.

The process of converting a debt obligation into a tradable financial instrument. Stable Debt Tokens enable this by tokenizing a loan into a standard ERC-20, allowing for:

• Secondary Market Trading: Debt can be sold to other parties.
• Use as Collateral: The debt position itself can be used in other DeFi protocols (with associated risks).
• Portfolio Management: Isolating and transferring specific interest rate exposures.

A lending protocol designed specifically to offer fixed interest rates for the entire loan term, such as Yield Protocol or Notional Finance. These are the native environment for instruments analogous to Stable Debt Tokens. They often use specialized mechanisms like zero-coupon bonds or interest rate markets to lock in rates, providing certainty compared to the dual-rate (stable/variable) model of protocols like Aave V2.

The enforced repayment of a loan triggered when the value of the borrower's collateral falls below a required threshold (the liquidation ratio). For Stable Debt Token holders, liquidation risk remains paramount. If the collateral value drops, liquidators can repay the debt token at a discount to seize the underlying collateral, closing the borrower's position. This mechanism ensures the solvency of the lending pool.